Educational Articles

The Dogs of the Dow Lose Some of Their Bite in May

Mario Ferro
| June 13, 2013

The Dogs Remain Out in Front

It continues to be a very good year for stock investors, with most of the major indexes showing solid double-digit gains through the first five months. Moreover, the Dow Jones Industrials and S&P 500 continue to hover around their all-time highs. A good part of this can be attributed to the Federal Reserve’s supportive monetary policies, while economic developments have also generally tipped the scales in favor of higher stock prices.

Meanwhile, the Dogs of the Dow are having an even better year, maintaining a cumulative lead through each of the first five months. Indeed, an equally weighted position in each of the 10-highest yielding Dow 30 Industrial stocks at the beginning of the year would have been up 19.2% through the end of May. By comparison, a similar weighting in all 30 Dow Industrial issues would have shown a gain of 17.5%. And, if you had been contrary-minded enough to go with the 20 “non-Dogs”, you’d be still be up a very respectable 16.6%.

We hasten to point out, however, that this has not been all doggy treats and runs in the park for our adopted pups. Indeed, while the Dogs (and the Dow as a whole, for that matter) have racked up gains each and every month so far, May’s advance qualified as such by only the slimmest of margins (0.03%, to be exact). Meanwhile, the rest of the Dow components were up 3.9%.

The two telecommunications giants (VZ and T) reported solid first-quarter earnings, and both appear on track to show good profit growth this year, so ongoing operations were not the culprit there. Rather, rising interest rates likely weighed on the companies’ shares. Specifically, higher bond yields make stock dividends less appealing as, if all else were equal, investors tend to prefer locked-in rates of return to the fluctuations in stock payouts. And, in this respect, Verizon and AT&T are the heavy hitters among the blue chips, recently yielding 4.12% and 5.05%, respectively, so it’s no surprise that they would be the hardest hit as bond prices fell last month. (Bond yields generally move in an inverse relationship to bond prices.)

Pfizer stock could also lay claim to some collateral damage from higher bond yields, as its recent yield of 3.42% is well above average. But, more likely, investors were mulling over the drug maker’s plans to spin off its majority stake in animal health business Zoetis (ZTS), and some of them may have simply decided to part ways at this juncture.

Meanwhile, after decent first-quarter earnings results, McDonald’s announced that April sales comps came in at a negative 0.6%, continuing the trend that held throughout the March period. Although the restaurant operator continues to operate against a difficult economic backdrop, we think the sales trend will reverse course later this year. The company is in a good position to succeed and pick up market share, thanks to its strong brand and impressive global infrastructure.

Top Dog: Hewlett-Packard

The performance of the computing behemoth’s shares continues to impress. In all, the stock has more than doubled in price since its 12-month low last fall when the company, under its CEO Meg Whitman, launched its turnaround strategy. H-P reported earnings of $0.55 a share for the April quarter, down from the $0.80 it logged in the year-earlier period, but better than management’s original outlook of $0.38-$0.40 a share. The report apparently allayed investors’ concerns that had dragged the stock down in April. It also prompted us to increase our share-net estimate for fiscal 2013, from $2.15 to $2.50, versus a deficit of $6.51 a share in the prior year. To be sure, H-P’s recovery is still a work in progress, but the company has made more headway than expected in the first half of fiscal 2013, and that is reflected in the stock’s impressive rebound from its recent nadir.

A Marathon, Rather Than a Sprint

As mentioned earlier, a good deal of the edge the Dogs have held this year rests on the shoulders of HPQ shares. That’s just the way things turn out sometimes. Last year, the relative performance of this strategy was hobbled by the stunning rebound in “non-dog” Dow component Bank of America (BAC - Free Bank of America Stock Report), whose shares more than doubled in market value over the course of 2012. But even then, the Dogs didn’t do badly, returning 7.1% versus 11.5% from an equal stake in all Dow Industrials. Moreover, the gap was even smaller when considering the Dog’s inherent dividend yield advantage. The bottom line is that this trading system should be considered as a long-term strategy, one that historically generates marginal, but cumulative, outperformance over time, while also simplifying investment-decisions, costs, and bookkeeping considerations.

At the time of this article’s writing, the author did not hold positions in any of the companies mentioned.